European Debt: The Big Picture

October 25, 2011 5:15 PM

For everyone struggling to get their arms around the debt crisis in Europe, Bill Marsh in the New York Times on Sunday (October 23) offers a compelling picture, literally, with graphic illustration for the key issues.

The picture is big, 18×21 inches. Either you need a very large computer screen or a hard copy of the paper (pages 6–7 in the SundayReview section, "It's All Connected: A Spectator's Guide to the Euro Crisis").

The main debt linkages across borders for which we have data are all here—and the graphic pulls your eye appropriately to the centrality of Italy in whatever happens next. (On why euro area policy towards Italy now matters so much—and what are the options—see my recent paper with Peter Boone, "Europe on the Brink.")

But you might think also about what is not in the New York Times graphic because we lack reliable information. For example, what is the exposure of US financial institutions to European debt, directly or indirectly, through derivatives transactions of any kind?

The opaqueness of derivative markets means that most investors can only guess at what could happen. Most of the relevant regulators and supervisors with whom I have talked seem also to be largely in the dark—remember the experience of American International Group, Inc. (AIG) in 2008.

Cross-border bank exposures through loans and other holdings are publicly disclosed—data from the Bank for International Settlements are represented by the arrows in the New York Times graphic. These data are surely not perfect, but they do convey the main points and they tell you where to focus attention.

Why do we not require publication of similar data, preferably by financial institution, for all derivative transactions—including both gross and supposedly net exposures across borders?

Also posted on Simon Johnson's blog Baseline Scenario.

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